Multi-factor Productivity (MFP): The Solow Residual

The Puzzle

In the late 1990s, something remarkable was happening to Australian productivity. Multi-factor productivity growth – the portion of economic growth not explained by adding more capital or labour – was running at over 2% per year. A decade later, it had collapsed to near zero, and by some measures had turned negative. What happened?

This question matters enormously for policy. Productivity growth is, in Paul Krugman's memorable phrase, "not everything, but in the long run it's almost everything." It determines living standards, fiscal sustainability, and the scope for wage growth without inflation. Yet when we try to measure it, we encounter a fundamental problem: productivity isn't directly observable. We can only infer it as a residual – the growth left over after accounting for measurable inputs.

This residual approach, pioneered by Robert Solow in 1957, has become the workhorse of productivity measurement. It has also been called "the measure of our ignorance." Understanding both its power and its limitations is essential for anyone working with macroeconomic data.

The case for RBA patience is getting stronger

Markets may be leaning dovish, but the data no longer is. Labour supply is slowing, inflation is synchronising upward, and supply-side optimism looks premature.

November Jobs: Market Caution May Be Misplaced

Markets moved quickly to reprice RBA rate expectations after today's November labour force release. But in their rush to declare the economy sicker than we thought, they may be overlooking the bigger picture.

The labour market is cooling, but not enough to ease inflation pressure. In fact, once you adjust for participation and NAIRU dynamics, the labour market remains tighter than it appears - and inflation is re-broadening. Markets may be reacting to the wrong signal.

The Neutral Rate Debate: What Comes After 15 Years of Emergency?

Introduction

Before 2008, nobody argued about the neutral interest rate. It was textbook macroeconomics: the neutral real rate (r) roughly equals trend real economic growth (g). For Australia, that meant r around 3-4%. Add the inflation target of 2.5%, and you get a nominal neutral rate of 5.5-6.5%.

The RBA cash rate averaged about 5.5% from 1993 to 2007, bouncing around neutral as the economy cycled through expansions and contractions. Rates went up when inflation threatened, down when growth weakened, but always gravitating back to that 5-6% centre of gravity.

This wasn't controversial. It was Econ 101.

Then Lehman Brothers collapsed, and everything we thought we knew about interest rates went out the window.

Building a Toy Macro Model for Australia

Bayesian approach to estimating NAIRU, potential output, and the output gap